Episode 33: Everything you need to know about franchising

Good business idea? Check. Great sales record? Check. Plans for world domination? Check. In this episode of Xero In we track the process from good idea to franchise success, and what it takes to get there.

This week on the show, Rob and JV are joined by franchising expert and founder of the Franchise Relationships Institute, Greg Nathan. With experience on both sides of the table, Greg debunks some of the myths around what it takes to build a thriving franchise empire.

“At the end of it all, if the franchisees are not profitable then you’ve got to ask yourself, ‘Why would I want to invest a whole lot of money in a business concept and barely make a wage out of it?’ I might as well go and get a job," says Greg.

Tune in to find out whether franchising could be the right fit for you.

Episode transcript

JVD: Yeah, really happy to be here again today because we’re going to look at a part of the Australian economy that I guess everybody has experience of because we’re looking at franchises.

RS: It’s going to be really interesting to find out from Greg Nathan what it means to be a franchisor or a franchisee and the current landscape that they operate in.

JVD: Absolutely, because he’s been all of the above, you know, he’s worked on both sides of the fence and now he’s actually working to improve the industry.

RS: Let’s go over to Greg now and find out what he has to say.

JVD: Absolutely.

JVD: We’re joined today by Greg Nathan he’s the founder of the franchise Relationship Institute. Welcome to the program, Greg.

GN: Hello.

RS: If you’ve got a great idea that you want to grow what type of questions should you be asking yourself when you are considering going through the franchise process?

GN: The big question you need to ask yourself is why. If it’s because you’re passionate about your business model, you believe that this business model serves a genuine need out in the community and there’s a lot of capacity for that to grow sustainably, it’s not a fad, it’s just going to last like two or three years, that then will sustain you when you go through the ups and downs. So that passion for your concept I believe is very important particularly if you’re founding a franchise system.

And what’s interesting in Australia today is the franchising sector we call it, it’s not an industry because it covers many different industries but the sector is maturing and some of the founders who are the people that started their franchise networks are now looking to sell and so we’re getting corporations coming in and buying these networks. It raises some interesting cultural challenges when businesses change hands. But my first point would be if you’re interested in becoming a franchisor and franchising your concept to other people, you must genuinely believe that it’s a sustainable profitable business model and then you’ve got to prove it.

JVD: Can you just tell us a little bit about what a franchise is and what the principle business elements are that make up that sort of franchise model.

GN: That is a really good question because there is a lot of confusion around the franchising sector. The first thing is that we look at franchising as a way – it’s like a verb, it’s something you do, a way of doing business. And so in that sense it’s a process and the stakeholders in this way of doing business is you have a franchisor who owns some intellectual property and has got a business concept that they’ve hopefully tried out and it works and it makes money. And that person then will license the rights to franchisees who will pay them an upfront fee typically to become part of their community of businesses and then an ongoing royalty. And so we’ve got the franchisee who’s paying money to the franchisor who owns the intellectual property rights.

RS: Franchising is one way, could you give us an overview of the other ways that you can grow and expand a great business idea and why you would select franchising over those other ways?

GN: Yes. Look you can run one business and make good profits and you can obviously use the internet to leverage your business and get access to lots of customers all over the world. So I think people underestimate sometimes what you can achieve with one unit.

GN: When you franchise you are getting typically 6% royalty, that’s your revenue stream on average from the franchisees. The franchisees will also typically contribute a marketing levy of – it ranges from 1-4% but that’s not revenue for you, that’s to be used to advertise and market the products and services. So you’re surviving on 6% and for that 6% you have to provide an infrastructure and support.

So you need to get up to 50-60 units, to start to be profitable. And there’s this myth that you can make a lot of money by franchising your business; it’s a very dangerous myth because what happens is people charge an upfront fee for joining the franchise network and that can range from $15,000 to $45,000. Now that money is meant to be spent on training the franchise – the new franchisee. It’s meant to be spent on the money to market your franchise opportunity, you know, to be able to do collateral and brochures and a really cool website to attract people to look at your business concept. That money’s not meant to be profit.

GN: Most franchise networks do have what’s called company-owned units and it’s around 14% and I think that’s probably a good number to have at minimum so you can pilot test any new products that you want to roll out or even technology these days is a big expense and a big risk, you know, it could be a new point of sale system or it might be some new digital marketing tools that you want to use. It’s always good to try those out in your company stores before you start piloting and rolling them out into the broader network.

JVD: And what if you’re on the other side and you’re looking at getting into your own business, I mean you have been in business before but you’re considering the franchise model, what are the questions you need to be asking as an incoming franchisee? How do you pick a model that actually is proven as opposed to another copycat store.

RS: Yeah, how do you pick the right one?

GN: The first thing I would say is that it’s no better to be a franchisor or a franchisee it depends on what you’re looking for. Some people don’t want to be a franchisee because they’re so creative and entrepreneurial they want to develop their own concepts. That’s your typical franchisor founder. But when it comes to making money, many franchisees make more money than the franchisor. So this is one of the myths, you know, that the franchisors are making all the money and the franchisees aren’t and we’ve just last week had a summit where we got together 78 multi-unit franchisees across Australia from 40 different brands to – to discuss how they’re going and, you know, share best practice and so on.

And a lot of those people are, you know, highly successful. Some of them have got 10-15 businesses that they’re running and I met a fellow just on the weekend, he’s got 50…

JVD: Wow.

GN: …franchises that he’s running and they’re all profitable. In America we have franchisees that have got over 1,000 units. And most successful multi-unit owners will have the dream or the concept in their mind that they want to run more than one. Nearly every successful multi-unit owner I’ve spoken to, when I’ve asked them did you always intend to become a multi-unit owner, they inevitably say ‘Yes, I always had in mind that I would be running more than one’.

And that brings us to the next incredibly important thing to do is to talk to as many existing franchisees as possible in the business. Not just one or two or three, but I’d be talking to 10. And some people would say, well, 10? That’s a lot of people. Well you’re signing up your life savings for, you know, hopefully five or 10 years and surely that deserves a fair amount of good research.

And the sorts of questions that you would want to ask existing franchisees is knowing what you know now…

GN: …would you make this decision again and if so, why or – or why not? What sort of support is the franchisor providing you and is that support meeting your needs as you’re developing because your needs in the first year of the business are going to be different to when you’ve been running the business for three years or four years. I would be going into head office or their support office and meeting the senior executives, asking them questions about their goals their plans for the network, really getting a feel for whether they’ve got clear strategies to meet the threats that will inevitably be coming down the pipeline in their particular industry. Asking them about the competitors and what’s their competitive edge to protect the network.

GN: Because at the end of it all, if the franchisees are not profitable then you’ve got to ask yourself why would I want to invest, you know, a whole lot of money in a business concept and barely make a wage out of it; I might as well go and get a job.

JVD: So don’t make the mistake of paying yourself the profits.

GN: No, because some people are saying, well I’m earning, you know, 60 or $70,000 out of the business, and they may be working six days a week. It’s a lifestyle choice for some people.

JVD: Yeah.

GN: I know in the travel sector, in the travel industries, travel agents will often – they don’t necessarily make a lot of money, but they have a great lifestyle and they travel a lot, they get the – they get free holidays and for them, they love it. And it’s great, they’ve got what they want. For other people it’s – no, this is a business and I have to choose if I’m going to get a job and I might, you know, earn, you know 80 or $120,000 and I don’t have a lot of the headaches and stress that I will have in looking after, you know, my own debtors and creditors and staff and so on.

JVD: How does that differ from the multi-unit model?

When we get into multi-unit, typically if you’re buying two units – I won’t talk about stores because in fact retailing these days is less than half of franchising. But two units you’ve got to start to work more on the business and rely more on your staff to be running things. Once you get to three units it all changes, there’s no way that you can be on the tools, running those businesses – like running them as in in the business.

Then I might evolve and take on two or three units I’ve now – I’m employing managers so I’ve got to pay extra wages and sometimes there’s a drop in performance of those people because they don’t drive the business quite as strongly as you will yourself.

JVD: So tell us a little bit about your own background, you’re obviously incredibly passionate about the franchise model. How did you first get involved with franchises and where does the passion for the sector come from?

GN: I grew up in a small business families, my uncles and my father all ran small businesses, so that was my education around the kitchen table having dad tell stories about, you know, the problems that he was having his managers and his staff and so on and how he was dealing with those.

He was in the automotive repair business and they had about 60 staff working for them and that was a family business. So I also got to see firsthand the dynamics of a family business, and most franchisees are, you know, a family business. There’s the husband and the wife and often the children are involved in the business.

I was a franchisee myself in the Brumby’s Bakery Group and I was with a business partner. We had three units and so I cut my teeth on that side of the franchising model and then I joined the franchisor and for seven years I worked as an executive in marketing and operations more in the leadership side of things. So I could see it from both sides and it’s interesting when you’ve got your franchisee hat on, you’re very obsessed with how much money you’re paying the franchisor and what sort of support you’re getting and your eye is rightly on your customers and your local market and sometimes you can become a bit egotistical and self-obsessed about what’s right for you.

When you’re in the franchisor’s side of things, you’re looking at the broad – the bigger picture, you’re trying to satisfy the needs of, you know, everybody. And so the reason why I started this business was to teach franchisees and franchisors how to collaborate effectively so that you can get over your ego and your petty mindedness and think in terms of what’s good for the long term of the whole network.

RS: So I think it’s fair to say there’s been increased protection afforded to the franchisees and it’s become a lot more legally onerous for the franchisors. I mean how can we avoid other incidences like 7-Eleven and Pie Face?

GN: The first thing is that the franchisor needs to be very clear that the number one measure of success has to be unit-level economics. They have to stack up, franchisee profitability.

And so I would say you know in franchising education franchisors need to constantly be reminded that they are not successful as a company if their franchisees are not making money and the business model doesn’t stack up. So that would be the first thing and that was also one of the issues that emerged from the Pie Face case study where there was rapid expansion which can be a good thing because the more units that you’ve got the more money there is to market and advertise.

However, those units need to be in premises where the rental is reasonable. And if you start paying rentals that make your business unviable then of course, that’s not a sustainable model. And just as an aside, rental costs are one of the biggest challenges facing not only franchising but small businesses generally in Australia at the moment.

RS: Why do you think the Australian model of franchising is world-leading?

GN: Well, we’re world-leading in some areas, we’re not world-leading in all areas. I think we have good culture of caring for our franchisees. Most franchisors are ethical they genuinely care about the profitability and the wellbeing of their franchisees. In the United States it’s a little bit more dog-eat-dog. And we’ve just had the head of the International Franchising Association visiting Australia and I was hosting him for four days in some meetings and so on. And that’s an observation that he made about the Australian culture generally, and also about our franchising culture that we put a lot more effort and care into looking after our franchisees in an ongoing basis.

RS: And where do we need to seek improvement?

GN: I think technology. I think America are very sophisticated for instance in how they use technology. We’re catching up there. When it comes to the whole marketing and sales process I think Australians, typically we don’t like to be too pushy and I think that’s kind of quite a nice quality in many ways, but I think we could become more sophisticated in how we market and, you know, the processes that we use for selling, I think in other cultures they may be a little bit more switched on on that side of the business.

RS: Do you think it’s become over-regulated and it’s too onerous for franchisors now and you know, what happens when the relationship goes bad? How do you part ways?

GN: I don’t think it is over-regulated. I think you know, if you look at America there’s 52 states and there’s 52 franchising codes. That is over-regulated. So if I want to expand into America I have to comply with 52 different sets of franchising regulations. In Australia we have one and so, and I think it is very important that we never go down that path where every state starts to develop its own franchising regulation. That would be a disaster. So at the moment I think we’ve got the balance right to protect the interests of everybody. Our research shows that typically in a franchise group let’s say of 100 franchisees at any time there will be 18% or 18 franchisees that will be unhappy for a range of reasons, it’s normal.

Sometimes the franchisees feel they’re not getting value for money for the fees they’re paying as their competence grows and their satisfaction starts to drop. And then there’s the free stage where they want to do their own thing and they’re saying, you know, you can’t tell me what to do, this is my business and so on. And then there’s a meeting of the minds often we call it, you know, the tough conversation where we sit down together and we renegotiate our expectations of each other.

And in my experience if the business model is sound and people are well intentioned that conversation typically happens about three years in, always results in a positive outcome where we get back to business. Satisfaction goes up and the relationship improves. But I’ve never spoken to a franchisee in my life and I’ve spoken to thousands of them, that hasn’t at some stage been extremely frustrated in their relationship with their franchisor and most of them, if the business model works, have got over it and have got back to business through just straight talking and collaboration.

JVD: Well it’s good to hear that good intentions don’t always lead us to hell.

GN: No, they don’t.

GN: Good intentions plus competence.

GN: – and a good business model. Yeah.

JVD: I just want to say thank you so much for coming on Xero In, you’ve provided so many interesting insights and I guess a pathway into business for people who have this big idea they want to expand, and for people who want to sort of give it a go, for the first time.

GN: Yeah, so my parting message is don’t become a franchisor if you don’t have the leadership and the vision and the money to invest in doing it right. And there’s nothing wrong with being a franchisee of a good business system.

RS: Fantastic.

RS: Thanks Greg.

GN: Thank you. Bye-bye.

RS: Great insight by Greg there around the importance of hiring the right people and just how critical it is to understand the unit economics of a franchise.

JVD: Yeah, see it’s interesting, I’d really focused on franchisees I guess as owning one maybe two units, this idea that you can do it en masse and that it really becomes a very different proposition once you own five, 10, 20, like – that’s huge.

JVD: And also that focus that we’ve often had on the fact that franchisors can grow their brand very quickly but also that franchisees have the opportunity to grow their own company very quickly effectively.

RS: That’s exactly right, you know, we often don’t think about franchisees being just a lucrative as the position of franchisor. So, you know, it’s such an exciting space of the small business economy.